There are a number of biases that creep into our investing decisions that have nothing to do with the investment itself. One of those is the concept of anchoring. We have a number in mind that we want to buy a stock at, or sell a stock at. That number may have no basis in reality. But it’s the number we have in mind. One of the places that it’s most insidious is with wanting to ‘get our money back’ on a stock that we’ve purchased that has declined. Often investors will sit in a poor investment for many years because they have anchored on a price, i.e., the price they originally paid. What I’m going to do is describe a way to overcome that anchoring.
You bought XYZ Corp. at $20 a share 3 years ago. It’s now languishing at $12. First things first. Is it still a good stock? Do you think it can be $30 five years from now? If so, then that’s not anchoring, it’s smart investing, waiting for the recovery. In fact the really smart investor might buy more shares. If it was good at $20, it should be great at $12. But what if that is not the case? The company is a one trick pony and everyone has seen that trick. Management’s answer is to manage costs better, not develop a new product. In that case it’s probably time to go. But you don’t want to sell because you want to ‘make your money back’.
Here is what to do. Instead of trying to make your money back on XYZ Corp, instead make your money back on a different, better stock. You think MNO Corp. really is a great company at $18 a share where it is now. Say you had 1,000 shares of XYZ Corp. So sell those 1,000 shares and take that $12,000 and buy 667 shares of MNO Corp. at the very same time. You’re still anchored at $20,000 as your original purchase, but now you’re in a much better stock. Plus you’ll be able to take an $8,000 tax loss on your sale of XYZ Corp.
Replacing a bad stock with a good one can be an effective way to overcome that anchor of a bad stock in your portfolio.